Online Bulletin no. 21

Marginal effective tax rates:

An obstacle to income improvement and social integration

for persons living in poverty

At the request of the Minister of Labour, Employment and Social Solidarity, the Comité consultatif de lutte contre la pauvreté et l’exclusion sociale adopted, in December 2015, an Advisory Opinion entitled Réformer la fiscalité pour tendre vers un Québec sans pauvreté.[1] This Online Bulletin covers in greater detail the Advisory Opinion’s recommendation number 6, on a reduction in marginal effective tax rates (METRs)[2] for low-income workers, whether or not they are recipients of last-resort financial assistance, which is one of the three priorities developed at the Minister’s request.

A long-known and long-criticized situation

The interaction between the tax regime for individuals and transfer programs can result in a significant reduction in the real income earned following an increase in the number hours worked. The recovery rates generated correspond to a reduction in social fiscal transfers and an increase in social contributions and taxation of taxpayers whose income has increased.

Depending on income brackets, all taxpayers are likely to be faced with METRs that are sometimes very high. One might think that our progressive taxation scheme would mean that taxpayers who are better off would face the highest income recovery rates. In fact, the data show that households with low or average incomes, including a significant number living in poverty, face the highest METRs, which in some cases are greater than 90%. That is the situation of many last-resort financial assistance recipients, be they covered by the Social Solidarity Program (with a severely limited capacity for employment) or the Social Assistance Program (without a severely limited capacity for employment.

This is not a new problem. A number of specialists on all sides have reported it in their work, several groups and stakeholders have criticized it, and the Ministère des Finances pointed it out in the 2015-2016 budget documents, following a recommendation of the Commission d’examen sur la fiscalité québécoise.[3] For its part, the Comité pointed out the problem in its third Advisory Opinion (published in 2009), which covered income targets.[4]

In its advisory opinion on taxation, the Comité identified the METR situation as a priority to prevent calling into question the principle of fair distribution of collective wealth and support for society’s most disadvantaged. The Comité used the example of the situation of Social Assistance recipients to illustrate the problem because those individuals are the most likely to be working and faced with high METRs. In this Online Bulletin, the Comité wants to broaden its analysis by examining the situation of Social Solidarity recipients since they are even more highly taxed when their work income is greater than the monthly amount allowed without a reduction in benefits, which in their case, is $100.[5] More than 127,000 Social Solidarity recipients have a severely limited capacity for employment. Many of them have significant impairments that prevent them from doing any work, while others are able to work to earn additional income and the number in that category could be higher if the taxation conditions were more favourable. Unfortunately, METRs even higher than those faced by Social Assistance recipients, particularly for the initial hours worked after crossing the threshold of the number of work hours permitted without reduction, have a chilling effect on any interest in increasing work hours and in some cases, when they also lose eligibility for their claim slips that gives access to various health services. In their case, METRs can vary from 75% to almost 90%.

As the Advisory Opinion on taxation points out, the following rates, updated to 2016[6] apply to Social Assistance beneficiaries without a severely limited capacity for employment:

METR and actual pay rate* for an increase of 10 work hours per week at minimum wage, once the threshold for work income allowed without deduction is crossed,
for various recipients without a severely limited capacity for employment
Recipient group / METR / Actual pay rate[7]
Independent adults / 69.5% / $3.28
Couples without children / 69.1% / $3.32
Couples with one child / 65.6% / $3.70
Single-parent household with one child (temporarily limited capacity) / 58.8% / $4.46

* The amount that actually goes into the worker’s pocket.

To more precisely show the situation of Social Solidarity recipients, we present the following rates that apply to various recipient groups with a severely limited capacity for employment:[8]

METR and actual pay rate* for the initial work hours, once the threshold for
work income allowed without deduction is crossed, for various recipients
with a severely limited capacity for employment
Recipient group / METR / Actual pay rate[9]
Independent adults / 89% / $1.18
Couples without children / 89% / $1.18
Couples with one child / 80% / $2.15
Single-parent household with one child / 75% / $2.69

* The amount that actually goes into the worker’s pocket.

A persistent problem that increases for some income brackets

It must be pointed out that taxation measures and the recovery of social fiscal transfers also put negative pressure on the incentive to work for recipients of Social Solidarity, as soon as the threshold of $100 of income allowed without reduction is crossed but also when the claim slip may be taken away from the recipient and in the context where premiums and credits begin to fall. The first dollars earned after the amount allowed are highly taxed. The rates decline a bit thereafter and then sometimes go back up significantly although income is still not very high.

In this respect, Prof. Claude Laferrière has pointed out, in charts published by him on the website of the Centre québécois de formation en fiscalité,[10] the high METRs which low-income and average-income workers face. The charts show METRs that are between 50% and 65% for independent adults with annual incomes between $15,000 and $20,000. The rates for single-parent and two-parent families vary from 71% to 92%, depending on selected situations where income brackets are from $35,000 to $60,000. The phenomenon is not limited to the lowest incomes.

Work premium, working income tax benefit and tax shield

Various measures have been implemented to reduce the effect of METRs on low-income workers. Some of them, particularly in the case of independent adults and couples without children, were increased in the Gouvernement du Québec’s 2016-2017 budget. Such an increase had been recommended in the Comité’s Advisory Opinion.

For certain situations and thresholds, the work premium, the adapted work premium and the federal government’s working income tax benefit (WITB) come into play to attenuate benefit reductions. In the case of the work premium, the rate increase is 9% for independent adults and couples without children and 25% or 30% depending on the type of household with children. The adapted work premium, which is available to recipients with a severely limited capacity for work, is 11% for independent adults and couples without children and 20% or 25% depending on the type of household with children. The WITB is 20.5% for households without children and 8% or 12% depending on the type of household with children.[11]

Another means implemented by the government to reduce METRs for low-income workers is the tax shield that was added to the tax regime as of the 2015 tax year. It is a downward adjustment of the net income used to calculate certain refundable tax credits. It applies for a particular tax year on the increase in income compared with the preceding year. The tax shield can result in an METR reduction on the order of 11 percentage points. Unfortunately, there is practically no effect on the situation of low-income workers who are also recipients of last-resort financial assistance, with the exception of single-parent families whose METR may be reduced by around 5 percentage points for the lowest income families.

These measures are certainly commendable, but the Comité believes that their effect should be greater and should, at the least, have an impact on the METRs of last-resort financial assistance recipients who work. The Comité points out the importance of implementing a mechanism making it possible to fairly compensate for an effective marginal rate that sometimes exceeds 90%.

Other actions needed

The government has shown itself to be aware of this issue by making improvements, in the last two budgets, to the measures in question so as to reduce the METRs which impact low-income and average-income workers. Such efforts must continue. The tax regime allows more fortunate taxpayers to avoid high recovery rates, under the pretext that they might reduce their offer of work. Following this same logic, it is inconceivable that taxpayers with low incomes would opt to increase their offer of work in conditions where a large part of their additional income would be taken away from them. It is imperative that individuals living in poverty be allowed to improve their financial situation by keeping a larger portion of their employment earnings, a portion minimally above the psychological threshold of 50% determined for higher-income taxpayers. This is a question of fairness and social integration. The approach should be to encourage gradual integration to employment by allowing individuals who work a number of hours more or less significant to hold on to a larger portion of the fruit of their efforts. Those individuals, who are often kept apart from social life, would gain in acceptance and in self-esteem and would be better supported in their efforts to increase their independence.

7

[1]. COMITÉ CONSULTATIF DE LUTTE CONTRE LA PAUVRETÉ ET L’EXCLUSION SOCIALE. Réformer la fiscalité pour tendre vers un Québec sans pauvreté, 2015, 47pages. (French only)

[2]. A marginal effective tax rate (METR) is a measurement based on the tax rate combined with the interplay of transfers (reduction or increase in credits, premiums, allocations and contributions of all types) following a reduction or increase in income. For example, a household whose gross income increases by $1,000 and keeps only $400 in disposable income will be saddled with an METR of 60%.

[3]. MINISTÈRE DES FINANCES. Québec Economic Plan, March 2015, page B23.

[4]. COMITÉ CONSULTATIF DE LUTTE CONTRE LA PAUVRETÉ ET L’EXCLUSION SOCIALE. Improving Individual and Family Incomes… Opting for a Better Future, 2009, 47pages.

[5]. Under the Social Solidarity Program, the exemption for work income has been $100 since 2005. That means, in particular, that the number of work hours at the minimum wage that can be carried out by a recipient without affecting the benefit amount has decreased over time. It was about 9 hours a month in 2016. The chances of earning any supplementary income become very limited given that jobs having such a low number of work hours are very rare. In its Advisory Opinion on taxation the Comité recommends that the monthly work income allowed without any benefit reduction be set on the basis of the number of hours at minimum wage rather than on a maximum amount.

[6]. Calculation made by the Comité by using the SimulRevenu tool available on Emploi-Québec’s website.

[7]. The Comité knows that this is not an actual pay rate, but uses that expression since it correctly describes the reality in terms of in-pocket income.

[8]. Calculation made by the Comité by using the SimulRevenu tool available on Emploi-Québec’s website.

[9]. The Comité knows that this is not an actual pay rate, but uses that expression since it correctly describes the reality in terms of in-pocket income.

[10]. www.cqff.com/claude_laferriere/accueil_courbe.htm. Page consulted December 5, 2016.

[11]. The Gouvernement du Québec has asked the federal government to adapt the working income tax benefit so as to make it possible to pay a higher percentage to households without children that are particularly impacted by high METRs.